By Mark Sheffield, Principal
ASL Emerging Business Group
Which is the better deal for a founder: 1) $500,000 for 10% of the start-up; or 2) $500,000 for 25% of the start-up? Of course, option 1) is better because it values the start-up at $5 million vs. 2) which values it at $2 million. A start-up business valuation for investment purposes is complicated and subjective; so many founders just wing it. That’s the wrong approach because founders risk undervaluing their start-up. It is better to negotiate from a position of knowledge and strength. The complexity in determining investment value is why founders need help.
Assume the business was actually worth $5 million in the above example. The founder loses $750,000 (or leaves $750,000 on the table) by settling for a $2 million valuation [$5 million x 15% (25%-10%) = $750,000]. Further, if down the road the business is sold for $10 million, the founder loses another $750,000 for a total of $1.5 million. If the business sold for $20 million the founder loses a total of $3 million. Is it worth the cost of only $3,000 to $5,000 for a quality start-up business valuation to save $750,000 to $3 million or more? You decide.
Contact Jeff Faust, Director of Valuation Services at ASL, who has expertise in valuing start-ups.